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Chapter 3Differentiate between accrual and cash-basis
accounting
2Copyright (c) 2009 Prentice Hall. All rights reserved.
3
Accrual Basis
Revenues are recognized when
earned and expenses are recognized when
incurred.
Cash Basis
Revenues are recognized when
cash is received and expenses recorded when cash is paid.
Not GAAPNot GAAP
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Accrual – Revenue recognized when services
provided
Cash – Revenue recognized when cash is received
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5
Accrual – Expense recognized when incurred
Cash – Expense recognized when cash is paid
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Define and apply the accounting period concept, revenue, and matching principles
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� Businesses prepare financial statements for specific periods to evaluate performance
� Basic accounting period = one year◦ Calendar year◦ Fiscal year
� Interim periods◦ Financial statements of less than one year
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� When to record revenue?◦ When it is earned
� What amount of revenue should be recorded?◦ Value of item or service transferred to customer
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� Measure all expenses incurred during the accounting period
� Match the expenses against the revenues earned during the same period
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� Requires that accounting information be reported at regular intervals
� Accounts are updated at the end of each accounting period
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Explain why adjusting entries are needed
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� Prepared at end of an accounting period� Assign: ◦ Revenues to the period when earned◦ Expenses to the period when incurred
� Update asset and liability accounts� Need to properly measure:◦ Net Income◦ Assets & Liabilities
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Journalize and post adjusting entries
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� Advance payments of expenses� Recorded as an asset� Adjusting entry records amount used as an
expense
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17
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Apr 1 Prepaid rent 4,800Cash 4,800
Prepaid rent for 6 months
4/1 4,800
Prepaid rent
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GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Apr 30 Rent expense 800Prepaid rent 800
To record rent expired in April
4/1 4,800
Prepaid rent
4/30 800
Rent expense
4/30 800
Bal 4,000
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� Plant assets◦ Long-lived tangible assets used in business operations
� Depreciation◦ Allocation of a plant asset’s cost to expense over its
useful life◦ Land is not depreciated
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GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
12 31 Depreciation expense $$$$Accumulated depreciation $$$$
Amunt calculated based on
depreciation method
Contra-asset account
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� Contra asset◦ Normal credit balance◦ Always paired with related account
� Holds sum of all depreciation recorded on a plant asset
� Book value:◦ Cost minus accumulated depreciation
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� Expenses incurred before payment is made� Opposite of a prepaid expense
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23
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Interest expense $$$$Interest payable $$$$$
To record accrued interest
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Salaries expense $$$$
Salaries payable $$$$
To record accrued salaries
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� Revenue earned before cash is received� Results in a receivable
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Accounts receivable $$$$
Service revenue $$$$
To record accrued revenues
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25
� Cash is collected before revenue is earned � Also called deferred revenue
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GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 1 Cash $$$$$Unearned revenue $$$$$
To record cash received before service is provided
GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT
Dec 31 Unearned revenue $$$$
Service revenue $$$$
To record earned portion of unearned revenue
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� To properly measure net income on the income statement
� To update the balance sheet
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Category of Adjusting Entry Debit Credit
Prepaid expense Expense Asset
Depreciation Expense Contra asset
Accrued expense Expense Liability
Accrued revenue Asset Revenue
Unearned revenue Liability Revenue
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Explain the purpose of and prepare an adjusted trial balance
� Prepared after adjusting entries are posted� Useful step in preparing financial statements
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Any CompanyWorksheet
December 31, 2010
Trial Balance AdjustmentsAdjusted
Trial Balance
Account Title Dr. Cr. Dr. Cr. Dr. Cr.Cash 5,400 Supplies 700 Equipment 17,000 Accum. depr. - Equip. 1,000 Accounts payable 200 Interest payableNote payable 9,000 Josie Smith, Capital 6,000 Josie Smith, W/D 1,000Service revenue 12,000 Rent expense 4,000 Supplies expenseDepreciation expenseInterest expense 100 Totals 27,200 27,200
a. 500
a. 500
b. 1,000
b. 1,000
c. 100
c. 100
5,400200
17,000
1,000
4,000500
1,000200
28,300
2,000200100
9,0006,000
12,000
28,3001,600 1,600
Prepare the financial statements from the adjusted trial balance
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Any CompanyWorksheet
December 31, 2010
AdjustedTrial Balance
Account Title Dr. Cr.CashSuppliesEquipmentAccum. depr. - Equip.Accounts payableInterest payableNote payableJosie Smith, CapitalJosie Smith, W/DService revenueRent expenseSupplies expenseDepreciation expenseInterest expenseTotals
34
5,400200
17,000
1,000
4,000500
1,000200
28,300
2,000200100
9,0006,000
12,000
28,300
Balance sheet
Income statement
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35
Revenue:Service revenue 12,000$
Expenses:Rent expense 4,000$ Depreciation expense 1,000
Supplies expense 500 Interest expense 200 Total expenses 5,700
Net income 6,300$
Any CompanyIncome Statement
Year ended December 31, 2010
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Any CompanyStatement of Owner’s Equity
Year ended December 31, 2010Josie Smith, Capital, January 1, 2010 $ 5,000 Add: Net income 6,300 Josie Smith, Capital, December 31, 2010 $11,300
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Cash 5,400$ Supplies 200 Equipment 17,000 Less: Accumulated depreciation (2,000) 15,000 Total assets 20,600$
Accounts payable 200 Interest payable 100 Notes payable 9,000
Total liabilities 9,300 Owner's equity Josie Smith, Capital 11,300
Total liabilities & owner's equity 20,600$
Any CompanyBalance Sheet
December 31, 2010
Liabilities
Assets
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